Gary Shilling: "Deflationary Pressures Are Being Felt Worldwide"

In the second article of a 3-part series, leading deflationist Gary Shilling continues to outline his case case for deflation and explains why deflation is so troubling to central bankers. His answer:

First, with chronic deflation, debts rise in real terms. Their nominal value remains fixed, yet nominal incomes and profits -- the wherewithal to service those debts -- tend to fall. So bankruptcies leap, and lending, the driver of much economic growth, atrophies.

Second, when deflation occurs, economies weaken and central banks lose much of their power. Interest rates fall to zero, and monetary policy becomes asymmetrical (because rates can only be raised, not lowered).

Third, real interest rates are always positive, even with zero nominal rates. That's been the case in Japan for two decades. This means that central banks can't create the negative real rates they desire to encourage borrowing. To be effective, they need to pay borrowers, in real terms, to take money.

Finally, deflation breeds deflationary expectations, which results in a sluggish economy. That's been the case in Japan since the early 1990s. Buyers wait for lower prices before purchasing, so excess capacity and inventories mount, pushing prices down. That confirms prospective buyers' expectations, so they hold off further, creating a self-feeding cycle of buyer hesitation, which spawns excess inventories and capacity that depresses prices and encourages further restraint by purchasers, and so on.

In the April 23 Bloomberg View article, Shilling goes on to explain that "Deflationary pressures are being felt worldwide."

The causes include slow growth in developed countries and now in China and other emerging economies. Prices are also falling because of the globalization of labor, leaping worldwide production, excess supply and declining commodities prices.

To make matters worse, global financial deleveraging, which also depresses growth, will probably persist for four more years or so, given that it normally takes a decade to unwind excessive debt after a major financial crisis (as happened in 2008).

Deleveraging has been so profound that it has largely offset the huge fiscal stimulus and monetary easing in the U.S. and elsewhere.

You can read the entire Bloomberg article here: